Analyst: It’s a Myth That Market Competition Drives Down Weapons Cost

By Sandra I. Erwin
Critics of Pentagon waste point to the uncompetitive defense industry — dominated by a handful of conglomerates — as the reason why the U.S. military overpays for weapons. If only there were a truly competitive, free, market, prices would come down, experts have argued.
Reality often trumps that theory, however. Some of the most hair-raising Pentagon acquisition programs — Future Combat Systems, Expeditionary Fighting Vehicle, Joint Strike Fighter come to mind — were competitively awarded after lengthy evaluations and technology trials. Yet, these programs today are held up as poster children for Pentagon acquisitions gone awry.
A respected defense budget analyst now offers a numbers-based hypothesis for why competition in military acquisitions is overhyped as a cure-all for the chronic cost overruns in Pentagon weapon systems.
“While competition has an intuitive appeal as a way to drive down costs in defense acquisitions, this is not always the case,” says Todd Harrison, a senior analyst at the Center for Strategic and Budgetary Assessments, a nonpartisan Washington, D.C., think tank.
“Competition can, under certain circumstances, drive up acquisition costs by incentivizing contractors to bid higher,” Harrison contends in a paper titled, “The Limits of Competition in Defense Acquisition,” published last month by the Defense Acquisition University.
The paper describes a competitive pricing model that allows acquisition managers to “game” how companies are incentivized to bid under different conditions. “The key question for acquisition professionals is not when does competition make sense, but rather when does it not make sense. … And when competition does have the potential to reduce costs, how can it be properly structured to increase the likelihood that savings are realized?” Harrison asks.
Cost savings are not guaranteed simply by having a vendor competition, he insists. Other factors that affect the price tag of a weapon system are the rate of learning in production, the relative costs of development, the first unit of production, and the total quantity of items being purchased.
“As defense acquisition costs have soared over the past decade, efforts at reforming the acquisition system have focused intensely on creating more opportunities for competition as a means to reduce costs and incentivize better contractor performance,” says Harrison.
The methodology he presents in the paper demonstrates that the “way in which a competition is structured can be a determining factor in whether competitive pressure is sufficient to balance the additional development costs of multiple contractors and higher unit costs from splitting the award,” he says.
The analysis reveals that, in some instances, the rules of the competition can actually “incentivize contractors to bid higher and drive up costs,” he says.
The Defense Department typically pays the full development cost for most systems through cost reimbursable development contracts or higher fees on fixed-priced contracts. “In order to create an opportunity for competition, DoD must pay (directly or indirectly) for two or more contractors to develop the same system,” says Harrison. “This redundant development work adds to the overall program cost.  Even if DoD pays for the development work only once and gives the same design to two or more companies for production (a “build to print” approach), it must still pay for the development of more than one production line.”
Once development work is complete, the Pentagon can choose a single vendor for production using a competitive process. “This effectively ends the competition and grants the winner a monopoly for future procurements of the same system,” he says. “Another option is to split the award between competing contractors to maintain the prospect of future competition. A split award, however, means that neither contractor receives as many orders and thus neither can progress as far down the learning curve as they could if only one firm were engaged in production.”
So, if competition does not guarantee lower costs, how then should the Defense Department best tackle the soaring price tags of its weapon systems?
Former Pentagon acquisition chief Jacques S. Gansler has concluded, after decades in the business, that there are no silver bullets. “It’s all about leadership,” he says during an Oct. 18 industrial-base forum hosted by the Lexington Institute. Successful leadership, in this case, is not giving rousing speeches about the need for savings and efficiency, but motivating the entire acquisitions workforce to make smart decisions, says Gansler. Even though budget cuts loom, the Pentagon continues to live in a “rich man’s world” where there is no incentive to be frugal. “If you want a Lamborghini, you just buy one,” says Gansler. Drastic spending cuts might have to happen, he suggests, in order to create the crisis that brings about constructive tension, and motivates the Pentagon to be less wasteful.
Photo Credit: Brookings Institution

Topics: Procurement, Acquisition Reform, Defense Department

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